Bridge financing definition
Bridge financing is a special type of short-term financing, generally for less than a year, that is used by individuals and companies to alleviate cash flow difficulties when a financial outlay is required well before a corresponding source of revenue is due to be delivered. Bridge financing is best known in the real estate industry, where it is often used by individuals and corporations to allow the purchase of one piece of property before the funds are available from the sale of another. Corporate entities also use bridge financing arrangements to fund operations prior to an initial public offering or to alleviate cash flow difficulties when expenses must be met before an expected source of revenue is readily available.
Types of bridging finance loans
Bridging finance loans are available in two basic classes. Closed bridging finance loans have a fixed end date by which the money must be repaid, and represent a higher risk for the borrower since penalties and loss of collateral may result from delayed payment. Open bridging finance loans are more flexible because they lack a definite end date, but may require higher interest payments in exchange for this added flexibility.
Bridge financing mortgage loans
The most common example of bridging finance is a short-term bridge loan that allows a homeowner to put a down payment on a new home before they have sold their current home; these types of bridge financing mortgage loans are usually paid off in a short time and may incur penalties if the home remains unsold for an extended period. Most bridging finance mortgage arrangements are intended to cover the gap between finalizing the purchase of a new home and closing the sale of the previous home; as a result, they usually only span a few months.
Bridge financing term sheet
The bridge financing term sheet is the primary document outlining the conditions, duration, and parties of the short-term loan. A typical bridge financing term sheet lists the identities of the borrowers, lenders, and any guarantors as well as the amount, purpose, and duration of the loan. Fees, interest rates, and other charges are also detailed on the bridge financing term sheet along with any collateral, specific restrictions and covenants, and the overall terms of the bridging loan. In many cases, the bridge financing term sheet also includes certain information about the financial state of the company in question. When the bridge financing term sheet has been signed by all parties, it becomes the basis for the bridge financing loan.
Drawbacks of bridge financing
While consumers can benefit from bridge financing mortgage arrangements and companies can solve cash flow problems by using this method, bridge financing can create significant problems if the necessary and expected revenue is not obtained in a timely fashion. Closed bridge financing is especially problematic, since failure to pay off the loan by the due date can result in loss of the collateral, interest and default penalties, or both; even open bridge financing contracts may require additional interest or assess additional charges after a certain length of time. Consumers and companies should use bridge financing arrangements only in cases where they are sure they can repay the loan within a reasonable time period.